‘Consumer behavior has changed’

Federal reform and customers’ frustration are affecting how banks do business

The last thing banks needed was a dustup with customers over new fees. The industry’s image had already taken a hit in the subprime mortgage mess, and many banks faced fallout from accepting government money in the Troubled Asset Relief Program (TARP).

Some big banks found out quickly last fall that consumers were in no mood to pay monthly fees for using their debit cards. The banks were trying to make up some of the money lost when new federal restrictions capped interchange fees charged to merchants in handling debit-card transactions.

The blowback reflected the growing testiness of consumers nationwide who are quick to use social media tools to flood the Web with complaints. In addition to fighting back against debit-card fees, customers in recent months have beaten back efforts by Netflix and Verizon Wireless to raise prices and fees on some services.

So, where does the banking industry now turn to recoup an estimated $12 billion in forgone annual income?

They won’t get it back through fees alone, experts say. “Fees are important to all banks in a low-interest environment,” says David West, senior vice president for Davenport & Co. LLC, a Richmond-based investment firm. “But they won’t be able to cover 100 percent of their losses by raising fees. It’s part of the recognition that consumer behavior has changed.”

Instead, banks likely will mix targeted fee increases with new services and products, West says. Some incentives are likely to go away as well. “The era of true ‘free checking’ at the big-bank level is over,” he adds.

Transitioning into a new approach to banking could be tough, especially for major banks that already offer extensive services and products. But some community banks and credit unions might find a silver lining in the dark clouds that linger over the industry.
Many of the obstacles banks face were long in the making. The overdraft and debit card restrictions weren’t. The overdraft restriction, which allows customers to opt out of overdraft coverage on their checking accounts, went into effect in July 2010.
The debit-card restriction, which cut in half the interchange fees large banks could charge merchants to process debit-card transactions, began in October. (It was the so-called Durbin Amendment to the 2010 Dodd-Frank Act overhauling financial regulations.) The fee cap of 21 cents applies to banks with more than $10 billion in assets.

Three credit unions, including Vienna-based Navy Federal Credit Union and Alexandria-based Pentagon Federal Credit Union, are large enough to be affected by the new restrictions, too. (Navy Federal, in fact, is the largest credit union in the U.S., with about $46 billion in assets.)

The restrictions are hitting banks hard. For example, San Francisco-based Wells Fargo estimates that the reduction in interchange fees will cut its earnings by approximately $250 million (after tax) each quarter beginning in the fourth quarter 2011, “before the impact of any mitigating actions,” says company spokeswoman Kristy Marshall.

“Interchange fees were a big source of revenue for maintaining checking accounts,” says Bruce Whitehurst, president and CEO of the Virginia Bankers Association.

Reaction was swift when some banks proposed charging customers monthly fees for using debit cards. Bank of America, the first to announce the fee, was hit especially hard by the backlash, which was driven in part by a social media-based campaign. The Charlotte-based bank withdrew its fee plan as did others such as Citigroup, JPMorgan Chase and Wells Fargo.

“We began a five-state pilot of a monthly $3 fee for users of our debit cards in October, but as a response to customer feedback the bank received, we cancelled the plan before the first charge was applied,” Wells Fargo’s Marshall says. The bank, which entered the Virginia market with its acquisition of Charlotte, N.C.-based Wachovia Bank in 2008, has not raised fees or minimum account balances in the commonwealth.

“It’s hard to start charging for something that was formerly free and deeply ingrained in our daily activity,” Davenport’s West says.
Given customers’ reaction to debit-card fees, making up for foregone income “is going to be tough for banks,” he adds. “They’ll mitigate some of it through generic service changes based on dollar balances or activity levels. But bottom line, they won’t be able to make up all of it.”

That means banks will need to boost earnings through a variety of ways, including cost cutting. “I don’t know any bank that hasn’t been focusing on cost-cutting and efficiency for the last four years,” Whitehurst says.

Wells Fargo has launched a companywide expense reduction program, for example. “While we are still in the early stages of this effort, we expect meaningful cost savings over time and are targeting $11 billion of noninterest expense for fourth quarter 2012,” Marshall says. “We are on track to achieve projected annual merger savings of $5 billion [from the Wachovia integration], consistent with our original projections.”

Many banks are likely to scale back some of their incentive programs, too. In addition to offering fewer free checking accounts, some banks will eliminate their rewards programs for debit card usage “because there are fewer benefits in getting customers to use them more,” West says.

On the other hand, fee-driven products and services are likely to emerge as revenue generators, especially among community banks, Whitehurst says. Yet, they won’t be fees that affect every customer. “If you look at deposit account fee schedules, you’ll see a lot of fees are customer-generated,” he says. “If you want a paper statement, then you may have to pay for that. So you might see more focus on à la carte, with the customer deciding how much they’ll spend based on their behavior.”

Banks also might offer better deals for customers who choose to bundle a group of banking services. “Bundling isn’t just about savings and checking accounts,” Whitehurst says. “A lot of banks are in wealth management and mortgage lending, for example. So you may see that a package of a broader array of products leads to a better pricing model” for the customer and more revenue for the bank.

“It’s all about finding the right balance of pricing and product,” Wells Fargo’s Marshall says. “We expect future volume, product or account changes may mitigate at least half of this earnings reduction over time.”

Perhaps most importantly for the short term, banks will have to engage in some image mending. A report released in December by the Chief Marketing Officer Council found that 87 percent of the bank marketers surveyed in the last quarter of 2011 believe “the current financial market turmoil is creating a difficult environment that is challenging them to reassure and more effectively communicate with their customers.”

“Whether we like it or not, we need to realize that we’re in an environment where the government and media have painted banks as the bad guys,” says G. Robert Aston, chairman and CEO of Hampton Roads-based TowneBank, which has $4 billion in assets. “We need to be transparent about what we’re doing and have good reasons for doing it.”

A boost for small banks
It’s not all bad news for the industry. The backlash against big banks — fueled in part by the Occupy Wall Street movement and the social media-driven Bank Transfer Day — has boosted the number of accounts in some community banks and credit unions.
Bank Transfer Day, which called for bank customers to shift their accounts away from big banks to community banks and not-for-profit credit unions by Nov. 5, was a grass-roots movement that initially caught fire through a Facebook event.

Among the apparent beneficiaries of the event was Richmond-based Union First Market Bank, which saw its deposit accounts grow by more than $50 million from July through September. When it began promoting its free checking and free debit-card products in August and September, checking account openings rose 69 percent from the previous year.

“There is a new frugality among consumers,” says Billy Beale, CEO of Union First Market Bankshares Corp., the bank’s parent company. “Clearly, the consumer is reacting adversely to fee increases at some national banks and other service providers. We think that customers are taking that opportunity to re-evaluate their banking relationships and seeing what other options are available.”

The bank, which has $3.9 billion in assets, operates 99 branches in Virginia. It opened nine new branches statewide and acquired one branch in Harrisonburg in 2011.

Navy Federal Credit Union saw its numbers rise, too. Last year, it gained 400,000 new members and saw its number of checking accounts grow 11 percent. “In normal years, we’ve averaged 7 percent growth in checking,” says Cutler Dawson, the credit union’s president and CEO. “We now have more members than we’ve ever had in Navy Federal.”

Membership is open to active and retired members of all branches of the military, along with their families, as well as Defense Department civilians. Navy Federal opened 13 branches last year, bringing its total to 220 throughout the U.S. It expects to open 13 more this year.

Richmond-based Virginia Credit Union, which has $2.2 billion in assets, got a membership boost last fall, as well, with a nearly 60 percent increase in new members in October as compared with the previous October. In November its new membership gains were 54 percent higher than the previous November.

“Some of it was attributable to Bank Transfer Day, but it was also our sharing news about our free checking,” says Chris Shockley, Virginia Credit Union’s executive vice president for member services.

Among the people eligible for membership in Virginia Credit Union are employees and retirees of Virginia’s state and local governments as well as students at state-supported colleges and universities, along with their immediate families and households.

“Banking services have become so complicated that customers will demand a clearer approach in dealing with changes,” Shockley says. “Our members tell us they don’t like surprises.”